Autos

Chris Bryant is a Bloomberg Gadfly columnist covering industrial companies. He previously worked for the Financial Times.

BMW sales reached a record in 2015 but it's hard to be too comfortable about how it's "selling" all those cars.

Some 46.3 percent of BMW vehicles were either leased or financed by its in-house financial services division in 2015. That's 4.5 percentage points higher than the year before. 

Credit Boom
BMW helped finance more than 46 percent of its own car sales last year
Source: BMW

The German carmaker's financial services business swelled 15 percent last year to 111.2 billion euros ($123.3 billion), more than double group equity of 42.7 billion euros. It's similar at Daimler, owner of Mercedes-Benz, where every second vehicle is financed or leased by its financial services unit.

BMW is celebrating its centenary and new CEO Harald Krueger on Wednesday unveiled a whizzy new strategy to take it into the robot-vehicle era. So it might seem churlish to focus on boring old finance.

But by leasing so many vehicles, BMW is building balance sheet risk that could come back to bite it if car markets deteriorate or interest rates rise. Granted, it doesn't look that way now. BMW can borrow cheaply and offer knock-down financing to customers, letting them trade up to dream vehicles they'd otherwise struggle to afford.

The return on equity at BMW's finance unit swelled to 20.2 percent in 2015. That looks pretty spectacular, especially when compared to returns at bank lenders. But is it sustainable?

Fizzing Finance
BMW's financial services arm is growing fast but risks lie ahead.
Source: BMW
NB. Shows balance sheet carrying amount

BMW customers aren't struggling to make payments. In fact, the credit loss ratio improved slightly to 0.4 percent last year. And lending against an asset that can be repossessed quickly (as opposed to a house) should be relatively low risk, as Bloomberg View colleague Barry Ritholtz notes.

However, BMW finance chief Friedrich Eichiner warned that the price of vehicles at the end of their leases has deteriorated "slightly" in the U.S. because there are so many used cars available. He said the trend would probably continue in 2016. 

Why does that matter? When a carmaker leases a vehicle to a customer, it sets the leasing rate based on what that vehicle can be resold for when it's returned after three years. If a carmaker misjudges the expected residual value -- say in the event of a recession or changing consumer tastes -- it can prove costly.

BMW has form here. In 2008 it booked a 2 billion-euro expense for bad debts and residual value risks, pushing net profit down by 90 per cent.

So even though new cars sales are booming, there are signs cheap leasing is storing up trouble in the second-hand market. More than 3 million U.S. cars will reach the end of their leases this year, 35 percent more than the prior year, Bloomberg reported last month. The sheer number of relatively young vehicles being returned is certain to push down prices. On top of that, sedan prices might also suffer from the resurgent popularity of trucks and SUVs.

U.S. wholesale used-vehicle prices as measured by the Mannheim Index fell 1.4 percent year-on-year in February, the fastest drop in more than three years. And BMW is exposed. The Americas accounts for 30 per cent of its retail customer-financing portfolio. Analysts have taken note, with Exane BNP's Stuart Pearson talking about its "possible unhealthy reliance on leasing."

Of course, BMW's solid profitability (the automotive unit's ebit margin was 9.2 percent last year) will be a cushion if residual values dive. But as they toast BMW's 100th birthday, investors would do well to recall the cheap money that keeps the champagne flowing, and ponder how long it can last.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Chris Bryant in Frankfurt at cbryant32@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net